Liquidity Supply in Uniswap v3: Rewards, Risks, and Market Shocks

Abstract

DEX like Uniswap v3 has gained significant attention in the blockchain industry, and understanding the driving factors behind liquidity provision is crucial for the platform’s success and adoption in the decentralized finance space. This study investigates liquidityproviders (LPs) behaviour in Uniswap v3 and their response to key events and developments,such as the EIP-1559 and the FTX collapse, to provide a comprehensive picture ofthe dynamics in the DeFi ecosystem. We explore LPs behaviour by assembling a datasetof 746,438 pool-day records associated with 2,228 Uniswap smart contracts. Two hypotheses,the ”Fee reward hypothesis” and the ”Impermanent loss avoidance hypothesis”are examined to understand LPs’ motivations and strategies. We further study the impactof EIP-1559 on liquidity provision, revealing a convergence in capital efficiency betweenlow and high-efficiency swap pools following its implementation. Last, we assess howthe FTX collapse affected trading volume, uncovering a more notable decline in tradingactivity among pools comprising exclusively of unstable coins as opposed to those withstablecoins only.